Defense industry news, analysis and commentary

WASHINGTON: Sequestration would force the Defense Department and other federal agencies to lay off workers long before the defense industry had to, said a report released today by the Center for Strategic and Budgetary Assessments.

Though big defense contractors, led by Lockheed Martin, have warned that the threat of sequestration might require them to send layoff notices to tens of thousands of employees just before the November elections, CSBA’s Todd Harrison said the effects of sequestration on defense companies would be delayed for months or years.

Not so with federal workers, who would feel the pinch at once: In the Defense Department alone, “about 108,000 of them would have to be furloughed or laid off, and that would happen nearly immediately, within days or weeks after sequestration occurs” on January 2nd, 2013, Harrison told reporters this morning. (The report did not estimate the impact on non-DoD agencies, which would be even larger).

The different impacts are due to the different rates at which the federal government spends money in different accounts. “There’s actually some cushion here for the defense industry,” Harrison said. “They primarily depend on procurement and RDT&E [research, development, test, and evaluation] funding.”

“The outlays for procurement are not going to drop by 10 percent in the first year,” he went on. “The people in the defense industry know this, and when they tell you that their labor force will have to be reduced by 10 percent because of sequestration, it’s true. It just doesn’t happen in January 2013: It happens gradually over the months and years that follow.”

Sequestration requires an automatic cut across the board — calculated by CSBA at 10.3 percent of non-exempt Defense Department spending — to what’s called “budget authority,” the amount of money Congress appropriates for various purposes. But not all budget authority is actually spent in the year it’s appropriated. Federal payroll is spent at once. Operations and maintenance funding — which buys ammunition, fuel, spare parts, and so on to keep troops training, ships sailing, and planes flying day to day — is spent fairly quickly too: 69 percent of O&M authority becomes outlays in the same year it is appropriated. But programs to develop and procure equipment have much longer lead times: Only 49 percent of R&D funding, and a mere 22 percent of procurement, are actually spent in the years they’re appropriated.

“On Jan. 3, nearly all defense contractors will be working on projects where funding’s already been obligated; that funding won’t be cut,” Harrison said.

The defense industry workers on every high profile program you can think of — the F-35 Joint Strike Fighter, the Littoral Combat Ship, the Joint Light Tactical Vehicle — are mostly being paid with money appropriated a year or more ago, under contracts long since signed. Those dollars won’t be affected by sequestration until 2014, when procurement programs would feel the pinch from automatic cuts made to the 2013 budget.

That doesn’t mean the defense industry is entirely insulated from sequestration’s impact, Harrison told reporters. Many companies make money not just by selling equipment but by supporting it through spare parts and maintenance contracts for years after the sale; that work is paid for out of O&M dollars, which are mostly spent in the same year they’re appropriated for, so on those contracts a sequestration cut to the 2013 budget would indeed be felt, mostly, in 2013.

So while sequestration would cut appropriations by 10.3 percent across the Defense Department (with war funding and military personnel exempted), the cut to outlays — the actual money spent in 2013 — would be lower: 6.9 percent for O&M, 5.9 percent for R&D, and only 3.5 percent for procurement.

As a result, the defense industry would not need to make layoffs in the near term, Harrison said. It’s the federal workforce that would take the immediate hit. President Obama has promised to exempt military personnel from sequestration cuts, which the law allows. But there’s no comparable protection for civil servants.

In fact, since sequestration would take effect in January, three months into the fiscal year, with a quarter of the money appropriated for federal payroll already spent, the Pentagon would have to cut payroll expenditures for the remaining three quarters of the year by 13.7 percent to make it come out as the required 10.3 percent cut for the year as a whole. “The longer they wait, the shorter the amount of time they have to make up that 10.3 percent reduction for the year, the more people they’d have to lay off,” Harrison said.

The impact on procurement and R&D would be less direct, although still disruptive. The Pentagon would have to renegotiate hundreds of contracts to fit within its reduced budget. Those renegotiations would require reducing quantities, which loses efficiencies of scale and raises the cost per item. So not only would the military have less money to spend, “you can buy less with the money you have,” said Harrison. A 10 percent cut in the dollar value of a contract will mean cutting the number of tanks, planes, ships, or bullets bought by more than 10 percent, he said: “I can’t just buy 10 percent fewer of them; I can buy 15 or 20 percent fewer.”

Harrison recommneded the Pentagon work out a reprogramming package to submit to Congress so it could shift money to protect high-priority programs. That’s politically very difficult, he admitted, but “it would be wise for them to start planning.”

Overall, Harrison said, sequestration would still be a nightmare. “This is a messy, a clumsy, a completely non-strategic approach to cutting the defense budget. This is not good policy,” he said. “It’s bad enough as it already is, as it’s written under law. You don’t need to exaggerate.”